Forex 28

Retail transactions in forex are closed by entering into an equal but opposite transaction with the dealer. For example, if you bought Euros with U.S. dollars, you would close out the deal by selling Euros for U.S. dollars. This is referred to as the offsetting or liquidating transaction.

Most retail forex transactions have a settlement date – date when the said currencies are due to be delivered. If you want to keep your position open even after the settlement date, the position must be rolled over to the next settlement date.

When you close out a trade, profits and losses can be calculated as follows –

Price when selling the base currency minus price when buying the base currency * transaction size = profit or loss.

If you buy Euros (EUR/USD) at 1.4707 and sell Euros at 1.4717 and the transaction size is 100,000 Euros, you will have a $100 profit.

($1.4717 – $1.4707) * 100,000 = $.001 * 100,000 = $100

Similarly, if you sell Euros (EUR/USD) at 1.4697 and buy Euros at 1.4707, you will have a $100 loss.

Open Positions

You can also calculate your unrealized profits and losses on open positions in just the same way. Just replace the current bid or ask rate for the action you will take when closing out your position. For example, if you bought Euros at 1.4707 and the current bid rate is 1.4703, you have an unrealized loss of $40.

Leverage and the risk vs reward

If you have an initial capital of $10,000 and if you trade on a 50:1 margin you can effectively control a capital of $500,000. However, a two percent move against your stand will completely wipe out your capital. A beginner trader should not ideally use more than 20:1 margin until you get comfortable with trading strategies.

What now is a 20:1 margin? With your $10,000 investment you will control a capital of $200,000. If you are trading the pair EUR/USD and have decided to take a long position (buy), it means you are betting that the USD will depreciate against the Euro.

For Example:

Let’s say current EUR/USD rate is 1.470. If your trading capital is $10,000 and your leverage is 20:1 you will effectively be able to convert $200,000 into Euros. If the current rate is 1.470 you will receive 200,000/1.470 = 136,054 Euros.

If the trade goes in your direction margin will work in your favour and 1% decline in USD will mean 20% increase in your start up capital. Lets see how this happens – if EUR/USD rate moves from 1.470 to 1.4847 you will be able to exchange your 136,054 Euros back to $202,000 for a profit of $2,000 resulting in a 20% increase in your initial capital from $10,000 to $12,000.

However, the converse is also true in that if the currency movement went against you and the USD appreciated 1% to 1.4553 your dollar conversion would deplete your capital by $2000.